Weighing the Week Ahead: Earnings Recession Ending Next Quarter?

This week’s calendar includes a little data, a lot of politics, slow summer trading, and the last of the earnings reports. I expect financial media to focus on an earnings season post-mortem by asking: Has the Earnings Recession Reached a Turning Point?

Last Week

The important economic news was excellent, and the market reaction was positive.

Theme Recap

In my last WTWA (two weeks ago), I predicted a focus on what the U.S. elections might mean for stocks. With major conventions in both parties and saturation coverage of anything said, that was a pretty easy forecast. My own final thoughts included the idea that there were not yet any clear implications. Since the major averages are about where they were in my prior post, the market seems to agree.

The business of figuring out what a President will do is pretty tricky. Morgan Housel uses historical data to rank past presidents on various criteria – stock market, profit growth, GDP, and inflation. Even knowing your history, the results will surprise you. The “best” presidents on these measure often started at a time when things were pretty bad.

The politics digested, the market turned to the biggest data of the last two weeks, the monthly employment report. The news relieved some continuing concern about the economy.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. While the range is pretty narrow, you can clearly see the early weakness and Friday’s rally to a new all-time high. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

  • Initial jobless claims remain low. There was a slight miss of expectations this week, but Calculated Risk provides the overall perspective.

  • Chemical activity hits a new high. Scott Grannis continues to follow solid indicators that most others miss. This one has a good record and “points to stronger growth than is widely perceived to be the case.”

  • Vehicle sales beat expectations, but some complained that higher incentives were required.
  • Employment increased solidly and more significantly than expected with a net gain of 255K payroll jobs and even more strength in the individual survey. While some are, as usual, seeking nits to pick, these data were an encouraging signal about economic strength. Expect the dialog to shift back to Fed policy. Bloomberg has good coverage.

The Bad

  • Rail traffic declined again. Steven Hansen covers the story including non-seasonally adjusted data in several time frames.
  • ISM services Index dropped slightly to 55.5, a little below estimates.
  • GDP growth was only 1.2% in Q2, significantly lower than expectations. Prof. James Hamilton has an objective analysis of what is going on. Hint: Inventories are crucial, and difficult to gauge. See also Bloomberg on the inventory story.
  • ISM Index dipped slightly but remained in expansion territory. Calculated Risk has the analysis and this chart:

The Ugly

Printed firearms on airplanes? The TSA caught this example, but there is a technology war going on. If you read the TSA Blog, you will see how many loaded weapons discovered at checkpoints.

 

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations are always welcome. There is plenty of misinformation to refute!

 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a moderate week for economic data, as earnings season winds down. While I watch everything, I highlight only the most important items in WTWA. It is important to focus.

The “A” List

  • Michigan sentiment (F). Good read on jobs and spending.
  • Retail sales (F). Consumer spending remains as a key factor for economic growth.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Wholesale inventories (T). Volatile June data, but an important part of gauging GDP.
  • Business inventories (F). More June data with implications for GDP adjustments.
  • JOLTS report (W). Important to understand labor market structure – not job growth.
  • PPI (F). This will become important after a few hot months – but not yet.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

The big story will still be corporate earnings. We have a little FedSpeak. Expect questions to focus on whether a policy change is more likely after the employment report. Don’t expect much new information before Yellen’s Jackson Hole speech. More politics, of course, but without a clear implication for markets.

Next Week’s Theme

Markets seem to have digested the Brexit story, and surprisingly shrugged off the terrorist violence. The economic data have quieted recession worries, and even turned positive. In the slow summer trading I expect more attention to analyzing earnings. Everyone will be asking:

Has the Earnings Recession Reached a Turning Point?

  • The bearish side will emphasize multiple points;
    • The streak of losses continues
    • Profit margins remain high, and (theoretically) vulnerable
    • Earnings results reflect stock buybacks and other financial engineering
    • And other points about how earnings are calculated.

In many ways, this debate will hinge upon forward expectations for the economy, business investment, and future profits.

As always, I’ll have a few ideas to add in the conclusion.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

The recession odds (in nine months) have nudged closer to 10%. This does not completely reflect Brexit effects, so we may get a further revision.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We have moved to a bullish market forecast. Felix is fully invested, including some more aggressive sectors. The more cautious Holmes is still about 80% invested. The recent strength has moved Holmes into the bullish camp, and we expect an increase in the number of candidates.

Top Trading Advice

Are you worried about “missing” a trade? Do you switch your system a lot? Do you make “boredom trades?” If your answer to any of these is “yes” you should read this post from Adam H. Grimes.

Is your trading affected by high-frequency models? Do you need to change your methods? Josh Brown has some answers and what you should be thinking about.

Brett Steenbarger distinguishes between successful discretionary traders and successful quantitative traders. Which are you?

Successful discretionary traders I’ve known and worked with have been distinguished by their level of market understanding.  Successful quantitative traders I’ve encountered have excelled at analysis and prediction.  Sometimes the successful discretionary trader makes use of predictive models as inputs to decisions; the successful quantitative trader will ground models in sound market understanding.  At the end of the day, however, quants trade their predictions and discretionary participants trade their understanding.  One trades universal patterns; another trades insights specific to what is observed here and now in a particular market.

 

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility! Mixing insurance and investments is a terrific way to kill two birds with one stone.

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Tony Isola’s discussion of widely believed lies. He includes a great list. I like so many entries that it is tough to pick a favorite. I’ll go with “Mixing insurance and investments is a terrific way to kill two birds with one stone”. What is yours?

Stock Ideas

The Zika virus is prominent in the news. While we all sympathize with the victims, we can also invest in companies working on a cure. Angus Nicholson of IG has some interesting suggestions for biotechs set to win big.

Chuck Carnevale turns his focus to dividend growth stocks in healthcare. This is an attractive sector, and he provides nine timely ideas in Part 1 of 3. This entry was excellent and we look forward to the future installments.

Holmes will begin contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here and Holmes will also post it each Friday in a Scuttle at Scutify.com. While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want this information, just sign up via holmes at newarc dot com and you will get email updates about exits. This week’s Holmes pick is Enbridge (ENB).

 

Market Overview and Outlook

Josh Brown explains (Rules-based tactical vs wizardry and witchcraft) why you should not attempt to imitate big-firm pronouncements by following their calls.

Eddy Elfenbein also weighs in on market timing, reporting the dramatic difference in a Fidelity study.

Avondale’s weekly Company Notes Digest is especially useful during earnings season. You do not have time to listen to all of the conference calls and you certainly cannot count on the media coverage. This is a good way to find important themes. (terrorism more important than Brexit). Also why Aetna is leaving the health insurance exchanges. And much more.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading, but my favorite is Jason Zweig’s important warning about the risks of too much stock in your 401-K account. He writes:

Since June, four dozen companies whose stock fell by at least half in 2015 have filed disclosure forms to the Securities and Exchange Commission on their 401(k) and other savings plans. By my estimate, workers at these companies lost $1 billion in 2015 by over-investing in the stock of their own employer.

This is very important. I frequently see such risks in the accounts of potential clients. It is one of the first things we fix.

Value Stocks

Since value stocks have lagged, many strong voices have suggested that the market message is that the economic cycle is over. I covered this subject last week. If you missed it, please take a look. I provide discussion of several stocks recently dissed in the media.

Watch out for….

For those at or nearing retirement, here are eleven common Medicare mistakes.

Final Thoughts

Over the past several weeks we have gotten quite a bit of new evidence to guide our investing. I see four major themes:

  1. Most investors seem to be looking beyond concerns about uncertainty and matters without quantifiable market impacts – Brexit, the election, terrorism.
  2. The economic data looks better than it did in the second quarter.
  3. Earnings expectations seem to have made a trough.
  4. Some sectors are much more promising than others both because of potential earnings growth and current valuation.

The biggest concerns relate to improving earnings, the need for more business confidence, and a resulting increase in corporate investment.

We are entering a period where we can expect a showdown on the economy and earnings – probably in Q3, despite the upcoming election. Fasten your seatbelts!

A Great Time to Invest? Right Now!

As markets make new highs many traders and investors have been left behind. Some are now considering climbing aboard. Fair enough, markets making new highs usually move even higher. Some worry that they have missed a false rally. Mrs. OldProf is encouraging me to keep it brief for a change, so you can just read the statement below if you want. Those who want some reasoning need to go through the rest. I have summarized the most important current issues as briefly as possible.

This is a good time to invest, and an exceptional one if you choose your holdings wisely.

What not to do

  • Do not worry about what stocks will do over the next ten or twelve years. You can and should revise your asset allocations regularly.
  • Do not obsess about the latest list of alleged “headwinds.” There is always such a list.
  • Do not fall for the pseudo experts on the Fed. Explaining markets by Fed actions alone is simplistic and inaccurate.
  • Do not worry about someone saying the stock market is “not cheap”. None of these methods work in real time and the inventors don’t even follow them.
  • Do not pile onto the crowded trades that worked last year. We are at a point of extreme distortion of sector valuations.
  • Do not let your political opinions undermine your investment success.

Ignore Economic Commentary

Most investors cannot distinguish the good from the bad, so it is better to ignore it! Here is why it is mostly biased and inaccurate.

  • Popular sources have media business models based on selling fear.
    • The biggest investment blog makes millions for the owners. Their readers have made even less than the “zero” quoted in their name!
    • Many prolific writers earn subscriptions, conference fees, and book deals with repetitive crash predictions. You know who they are, and probably read them regularly.
  • Many widely-quoted experts are simply pro-bonds, anti-stocks. If someone sells only bonds or runs a research operation for the bond community, you know what to expect.
  • Many noisy commentators are selling high-commission products based upon fear.
    • Read the fine print on “structured products.”
    • Do not get dazzled by the multi-page annuity proposal. The one where you are supposed to initial each page. Email me first for a second opinion.
    • Beware of gold purchases with big commissions and little liquidity. If you want gold, make sure it is a reasonable part of your asset allocation.
  • Election season emphasizes negative sound bites. Candidate competition, and especially parties out of power, want to paint the worst case. This is not a partisan political point; it happens whichever party is in power.

The combination from all of these sources creates a negative picture that is difficult to put aside – especially since part of the story is true.

The Investment Climate

The current climate has two very distinct parts:

  1. Popular. Anything that has an attractive dividend or captures a popular buzz has been bid up to a high price.
  2. Unpopular. Anything that depends upon economic growth and improving prices has been out of favor.

Your Playbook

Whenever there are extremes it represents an exceptional opportunity for the insightful investor. You may never find a better time to buy cheap stocks (on a P/E basis) in cyclicals, energy, materials, technology, and financials.

The new market highs are a bullish sign. The market may move higher, as the astute Eddy Elfenbein is suggesting in this CNBC segment. (In 2010 I predicted Dow 20K rather than Dow 5000, a popular theme at the moment. Eddy suggests that it could happen this year). The anchor acts like Eddy is crazy. It is only an 11% gain from here. CNBC regularly features people calling for market declines of 40-50%. This segment has some good stock ideas as well, including Goldman Sachs, IBM, JP Morgan, and Microsoft.

The media world has turned into a silly competition to present the direst prediction. Some forecasters are determined, for whatever their motives, to scare you witless (TM OldProf euphemism). Those who are bullish are scorned for suggesting that the new highs might lead to another 10% or so. In fact, if you pick the right stocks, the gain could be much greater. I find a lot of stocks that are 25% or more undervalued.

If you do your homework, it is pretty easy to construct a portfolio with a P/E that is significantly lower than the overall market – even sticking to large or mid-cap stocks that anyone might want to own. Apple is an obvious example. Ford? Best earnings ever and the best-selling vehicle. P/E under 7 and dividend yield almost 5%. That is an excellent example of the intense skepticism of this market.

Conclusion

There is definitely a bubble, but not where most think. Look at any stocks in the “quest for yield.”

Even if you do not expect big gains from the overall market, there are plenty of sectors ready for an explosion. It is a great time to invest in stocks, or to improve your asset allocation. You have a lot at stake.

Weighing the Week Ahead: Will Earnings Expectations Sustain the Rally in Stocks?

This week’s calendar includes a pretty normal schedule, but not the most important economic reports. There will be an abundance of FedSpeak, with questions about last Friday’s employment data. Despite this, the real story will be the start of earnings season. Expectations are pretty low. Statements about the outlook are always important, but that is especially true right now. The financial media will be asking: Can the profit outlook sustain the rally in stocks?

Last Week

The economic news was pretty good, and the market reaction was even stronger. The continuing market rebound has caught many off base. This week’s review emphasizes Friday’s employment report, since that was the biggest news.

Theme Recap

In my last WTWA, I predicted that the post-Brexit rally might continue if the economic news was good. This could lead to discussion of a possible “summer rally.” After a poor start to the week, the economic data finally turned the trick. From my “final thought” from last week:

Rightly or wrongly, much will depend on the employment report. The economy is the key to future earnings. Recession odds are low, earnings are improving, the oil issue has stabilized, and the Fed is on hold.

In addition to summer rally discussions, there was continuing skepticism – sucker’s rally, bull trap, and similar terms were bandied about. Sometimes I am right about the theme, but incorrect in my expectations. Last week both were on target.

The Story in One Chart

I always start my personal review of the week by looking at the great chart from Doug Short that summarizes the week. Since that post has not yet been updated this week, here is the picture from CNN Money. It was a pretty quiet week until the big Friday rally.

cnn weekly

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

  • Rail traffic is showing improvement, but the story reflects some mismatch in holiday timing and weaker comparisons. (Steven Hansen).
  • Las Vegas real estate sales are improving, up 7.1% year-over-year. Calculated Risk notes:

    This is a key distressed market to follow since Las Vegas has seen the largest price decline of any of the Case-Shiller composite 20 cities.

  • Energy prices are lower, with gasoline down 50 cents from last year. The Oil and Energy Insider has plenty of good data. The charts show the forward curve of prices – not just the current spot. U.S. Production continues to decline.

d577d024-1c19-4bb4-b105-28f47c541823

  • Spenders coming back from the mortgage crisis? Victoria Stilwell at Bloomberg makes the case, noting that time has “healed the wounds” allowing more credit for those who had foreclosures.
  • Long-leading indicators have improved. New Deal Democrat has a mid-year summary of ten indicators with demonstrated lead times. This is well worth a look. One nugget among the many good ideas:

    The yield curve remains as positive even now, with the same slope as it had in the middle of the 1970s, 80s, and 90s expansions.  The 5-year spread is even wider than it was during most of the 1960s.

  • ISM services handily beat expectations (56.5 versus 53.3 expected and 52.9 last month). Scott Grannis analyzes the components and has a good chart comparing the U.S. to the Eurozone. He suggests that worries may be over-stated.

US vs Eurozone Serv

  • Employment news was good. We should follow multiple sources on employment, especially because of the volatility and revisions in the “official” data. This week the news was all good, but perhaps not as good as the initial market reaction would suggest.
    • The ADP reported a gain of 172K private jobs, beating expectations of 152K. This is an important independent source.
    • Initial jobless claims hit a new low at 254K, beating expectations by 14,000.
    • Non-farm payrolls recorded a stunning net gain of 287K, exactly the opposite of last month’s result of 11K after revisions. This was good news, but not as good as it seemed. It requires a deeper look.
      • Commentary varied widely. For details, check out the summaries at Bloomberg and The Wall Street Journal. The bearish pundits either denied the strength, said that the market was not prepared for a rate increase, or both. Bullish commentators saw Santa in July, a reassuring number that would not cause the Fed to react.
      • Many fine sources showed balance. This report was not as good as it seemed, nor was last month’s so bad.
      • The charts are always interesting. Here are some of the most important from The WSJ and Bob Dieli’s monthly employment report (subscription required). To summarize from the WSJ, the change in earnings growth is still disappointing; most net job creation is full-time, the number of those wanting but not getting full-time jobs has declined significantly. From Dr. Dieli, the overall path of growth is the main theme. The duration of unemployment is an important and often-neglected story. Both sources have many more helpful charts and plenty of analysis.

2016-07-09_19-16-59

 

2016-07-09_19-19-18

2016-07-09_19-17-53

dieli employment

dieli duration of unemployment

 

The Bad

  • China rollover risk. Tom Orlik at Bloomberg Intelligence analyzes the current situation and the need to roll over $24 trillion in debt.

    The amounts involved, the maturity mismatch between assets and liabilities, and the fragile state of final borrowers all increase the chances of a misstep — and the severity of an impact should one occur. That underlines the importance for the government to maintain buoyant nominal growth, ample liquidity and low interest rates.

  • Manufacturing orders declined by 1%. Steven Hansen (GEI) has the full story with multiple takes on this data series. He sees more of a mixed picture.
  • The worldwide yield curve is flattening. Ed Yardeni discusses this story, concluding that while not recessionary, it bears watching.

FIG1

The Ugly

Three days of violence. Like everyone else, I was sickened and saddened by events. Leaders of all stripes had comments. My own favorite professor, Neil Browne, always emphasized the need for Asking the Right Questions. Although he has allegedly retired, his mission continues. He posted a thoughtful and insightful perspective.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations are always welcome. There is plenty of misinformation to refute!

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a fairly normal week for economic data. In my calendar I highlight only the most important items, helping us all to focus.

The “A” List

  • Retail Sales (F). Will this reflect improved sentiment and employment?
  • Industrial production (F). A volatile data series–closely watched given the recent manufacturing weakness.
  • Michigan Sentiment (F). Good read on employment and spending.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • China Q2 GDP (F). It is amazing how quickly this number is generated….
  • CPI (F). May start to get some attention if the expected increase occurs.
  • PPI (Th). See CPI.
  • Fed Beige Book (W). Descriptive reports from various Fed districts, prepared for next FOMC meeting.
  • Business inventories (F). May data, but relevant for GDP.
  • Wholesale inventories (T). Volatile May data – a factor in GDP calculation.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

The big story will be corporate earnings. Fed fans can enjoy appearances from at least six of the regional Presidents. Expect each to be asked if Friday’s employment data changes the likely timing and number of rate increases.

Next Week’s Theme

Markets seem to have digested the Brexit story. The economic data have quieted recession worries. We can expect plenty of post-holiday FedSpeak, but little real news from those sources. It is the start of the Q2 earnings season. There are questions about both the top and bottom lines, but expectations are pretty low. The real question is about the future.

Everyone will be asking:

Can the profit outlook sustain the rally in stocks?

Feel free to join the discussion in the comments, but I see three key questions:

  1. Will the outlook for earnings be stronger?
    1. Optimists note that the dollar has stabilized, as has the decline in energy. Earnings expert Brian Gilmartin has emphasized these themes, while still noting the sequential declines in revenues and earnings.
    2. Pessimists emphasize the “earnings recession” and the sluggish second-quarter economy.
  2. Will stocks respond if the earnings outlook is good?
    1. Optimists note ultra-low valuations in many economically sensitive sectors. These stocks have room to run skepticism wanes.
    2. Pessimists point to lagging sectors that seem to lack upside. And of course, the familiar themes about overall market valuation.
  3. Will fundamental improvement be supported by the technical analysis followers?
    1. Optimists see a potential breakout from the long-run trading range.
    2. Pessimists see an overbought market.

 

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

indicator snapshot 070816

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

This week the recession odds (in nine months) have nudged closer to 10%. This does not completely reflect Brexit effects, so we may get a further revision.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update describes the elements of the indicator we cite every week.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

As we review the weekly indicators it is important to maintain perspective. A 20% chance of a recession would be average. It is not a reason for fear, since it says that a recession is very unlikely. There will be a time to exercise more caution, but we are not yet close to that point. There are many very questionable recession stories right now.

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix remains almost fully invested, including some of the currently-popular fixed income sectors. That is working well. The more cautious Holmes is still fully invested, in a diverse group of 16 stocks from a universe of nearly 1000, selected mostly by liquidity. That group is also responding well. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

Worried about the Bloodbath of 2016 and post-Brexit fallout? The Trading Goddess has your back with ten suggestions. My favorite is the pocket chain saw.

Wondering when to sell? Adam H. Grimes helps with the question of when to take profits.

Brett Steenbarger shows the preparation needed for trading. (Start at 3 AM? Hmm). He does describe the need to have a balance including some quality time away from the market.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week (HT Abnormal Returns), it would be Phil Huber’s Fun With Strikethroughs: Wall Street Maxim Edition. He takes on the common misperception that good investing can be accomplished through a few simple rules, and he does so adroitly with humor. You will enjoy the entire list, but here is my favorite:

As goes January, so goes the year nothing.

Stock Ideas

Chuck Carnevale is cautious, even including the dividend aristocrats. He carefully describes his valuation concerns while highlighting the best candidates.

Philip Van Doorn (MarketWatch) has more stocks that were hammered by Brexit yet still favored by analysts. Those shopping for laggards may wish to take a look.

Market Overview

Shawn Langlois’ excellent “Need to Know” column features a variety of interesting market perspectives. This week’s “the call” segment featured Joe Fahmy’s four reasons for the Dow to hit 20K this year. (Check out www.dow20k.com for a prediction on this subject made in 2010 – when the Dow was at 10K).

Laszlo Birinyi publishes an excellent monthly newsletter (subscription required). He covers many analytic methods, but he features a collection of past media stories on the market. It is a helpful way to keep perspective. Take this one for example:

[Jeff] This might sound like something from last month, but it was actually written in 2010.

[Jeff] Maintaining the right long-term perspective is one of the biggest challenges for investors. I cite this striking example not to highlight the error of a single analyst. It was mainstream — a prevailing opinion published in a leading source.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors. This week, during his well-deserved vacation, he invited suggestions for good posts that had not gotten much attention at the time of original publication. This produced a number of high-quality ideas that he featured throughout the week. I am not surprised. My sense of something that is really good does not always resonate with readers. Other bloggers share this experience.

I am featuring one of these posts as this week’s best. In addition, please check out Wednesday’s article on Portfolio Management, and have a look at my suggestion. Cullen Roche’s piece on fear and negativity also has a timeless quality.

Watch out for….

The so-called “safe” stocks. These stocks are so overbought that it was a prevalent theme in this week’s investment advice.

Ian Bezek warns about utility yield chasing.

Ellie Ismailidou and Anora Mahmudova (MarketWatch) have a similar warning.

Corporate bond yields are also threatened (Barron’s).

Barron’s questions the fundamentals of the utility business – slowing growing demand vs. supply.

Final Thoughts

 

Stocks will eventually respond to an improving economy. We might have to wait for third-quarter earnings reports, another three months. An improved outlook will speed up this process, since stocks have tracked forward earnings. Improving the outlook will improve those projections.

Jeremy Siegel explains how stabilizing energy stocks, low interest rates, and improved earnings could lead to a 15% increase in stocks.

Years ago we could expect conference calls to “talk up” both current news and future prospects. A skeptical attitude was a healthy approach! More recently, CEO’s seem more interested in keeping expectations low. The financial community will pounce on negative statements and extrapolate to similar companies. It should be a great story.

The rotation from yield stocks to cyclical names and financials is the best opportunity for long-term investors.

But even more patience might be required.

 

Weighing the Week Ahead: Time for the Summer Rally?

This week’s calendar includes plenty of data and a holiday-shortened week. The employment report looms, with many worried about a repeat of the weak May results. With Brexit apparently digested and the Fed on hold, I expect some attention to the possible upside. The financial media will be asking: Is it time for the summer rally?

Last Week

Brexit was the big story. The market rebound was surprising to many, forcing a change of perspective. The economic news was mostly good, but got short shrift.

Theme Recap

In my last WTWA, I predicted another week about Brexit, with emphasis on the possibility of a market turning point. That is certainly how the week started. CNBC even bumped Shark Tank and the West Texas guys from the 7PM EDT slot for another round of Markets in Turmoil. After stocks moved higher, the schedule went back to normal.

Last week’s “Final Thoughts” section was also on target, suggesting a weak Monday, but emphasizing the need for investors to consider the plausible range for the week’s trading.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the exciting path for the week – early weakness from the continuing Brexit selling, a big, three-day rally, and a flat Friday as people left early for the long weekend. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

  • The ATA trucking index for May was strong up 2.7% on a seasonally adjusted basis and 5.7% year-over-year. (Calculated Risk).
  • Congress and the President managed enough cooperation to pass Puerto Rico relief legislation. (The Hill).
  • Consumer confidence increased significantly to 98 versus the prior reading of 92.4. This beat estimates by over 5 points, but some noted that the survey preceded the Brexit news.
  • Personal spending increased 0.4% m-o-m and almost 5% over the prior year. This will be a positive for Q2 GDP.
  • Fed stress tests were positive, as was the case last week. This week the question was whether banks could execute plans for dividends and stock buybacks. Nearly all passed, but Morgan Stanley was a notable exception. (MarketWatch).
  • The ISM report was strong. The index reading of 53.2 (if annualized) is consistent with GDP growth of 3.2%. Scott Grannis illustrates this relationship.

NAPM vs GDP

 

Looking at the sub-categories provides some useful color.

ISM June 2016

 

The ISM also has a separate report on expected Brexit effects. I found them to be surprisingly small. The Chicago PMI also showed a very strong increase. (Calculated Risk).

The Bad

  • The rail contraction continues although the rolling averages are improving a bit. Steven Hansen has the update.
  • Pending home sales decreased 3.7% in May and 0.2% y-o-y. (Calculated Risk).
  • Construction spending decreased 0.8% in May. Calculated Risk notes that this is mostly from public spending, illustrating with this chart:

ConSpendMay2016

 

The Ugly

Rio Olympics. The stories are starting to mount, with the WSJ calling it a perfect storm of problems. The recession has crushed budgets for public services. Violence and pollution have grabbed headlines. Zika is causing some athletes to reconsider participation. It is a shame that a great tradition is threatened.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s winner is CNBC anchor Sara Eisen, for her first-rate, myth-busting interview with Fed Vice-Chairman Stanley Fischer. (Transcript and video via CNBC). One-by-one she asked all of the key questions in the current debate over Fed policy – potential for negative rates, Brexit impact, does the Fed make decisions based the economic impact abroad, the state of the economy, recession potential, employment, George Soros, and the strong bond market. Whether or not you agree with Vice-Chairman Fischer, it is important to know what he thinks.

Sara Eisen displayed first-rate journalism, as expected from a Medill School graduate. Unlike so many other financial interviewers she did not argue with her subject nor push her own agenda. She did raise all of the current Fed misperceptions common in the trading community. Her preparation and poise helped us all learn important information. It was well worth turning off my mute button and dialing back the TIVO.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a big week for economic data, and only four days of trading. I expect it to start slowly culminating in the biggest news on Friday. In my calendar I highlight only the most important items, helping us all to focus.

The “A” List

  • Employment report (F). Deserved or not, this is always the biggest news of the month. Rebound expected.
  • FOMC Minutes (W). You might wonder how this could provide fresh news. The punditry will find a way.
  • The ISM Services Index (W). Will strength match the manufacturing index?
  • ADP Private Employment (Th). A good alternative to the “official” numbers.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Factory orders (T). Volatile May data, but an important sector
  • Trade Balance (W). Also May data, but a factor in gauging GDP.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

The week may start a bit slowly as participants return from the long weekend. There is plenty of FedSpeak for those needing a fix. More Brexit commentary and predictions will also be a feature, with emphasis on European markets and specific companies.

Next Week’s Theme

After two weeks of Brexit stories, market participants seem ready to move on. We have a pretty busy week for economic data, with the news occurring over only four days and a sleepy start on Tuesday. Friday’s employment report will be the big story of the week, and might be a multi-day theme.

Despite this, I am intrigued by two posts from my blogging friend Eddy Elfenbein. (Eddy seems to have scored a regular appearance gig on CNBC. His comments are always on target, and they should give him more time. I turn off the mute and TIVO back whenever I see him).

First, Eddy noted that the market has been in an extremely tight trading range for almost two years.

Second, he crunched some data showing one-day results for every day of the year for a 120-year period.

One

The two-month period beginning right now has historically provided about half of the annual stock gains. Eddy wisely warns that this is interesting, but not a basis for prediction. I agree, but the theme should attract some attention.

In addition, the Fed is expected to remain on hold and Brexit worries digested. Many will be asking:

Is it time for the summer rally?

Feel free to join the discussion in the comments, but here are the key themes I see.

Bearish

  • The rally has created an overbought market.
  • Market valuation is extended and earnings are weak.
  • Brexit remains important – more than people realize.
  • There is a real threat of global recession.

Bullish

  • The Brexit story seems to have a favorable ending. Ed Yardeni writes:

    The Brexit vote didn’t change my secular bullish stance. That’s because I don’t believe it will cause a recession in the US. I expect that earnings growth will resume during the second half of this year and that interest rates will remain as low as they are now for the foreseeable future.

  • Earnings may well be at a turning point. (Brian Gilmartin, with some support from FactSet).
  • Recession odds (judged by the best methods) remain very low. Stock prices erroneously reflect high macro worries.
  • Low interest rates make stock returns attractive to many investors.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Indicator Snapshot 070116

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

This week the recession odds (in nine months) have nudged closer to 10%. This does not completely reflect Brexit effects, so we may get a further revision.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

ECRI-WLI-YoY-since-2000

 

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update describes the elements of the indicator we cite every week.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation. Dwaine’s most recent update, shows the increase in the number of countries with back-to-back quarters of losses in GDP.

2016-07-01_1721

 

As we review the weekly indicators it is important to maintain perspective. A 20% chance of a recession would be average. It is not a reason for fear, since it says that a recession is very unlikely. There will be a time to exercise more caution, but we are not yet close to that point.

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix remains almost fully invested but with somewhat more cautious choices. This was good for most of the week. The more cautious Holmes is still fully invested, in selections that dodged the Brexit fallout pretty well. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

One of the reasons I enjoy and learn from Brett Steenbarger is the unique quality of his insights. He often discusses a topic that you might think is simple and obvious in retrospect. The value is that no one actually follows the key process in real time! His recent post on Confusion and Clarity in Trading is an excellent example. How many times are you in a situation where you simply do not know? How often do you admit it?

Adam H. Grimes also has simple but powerful advice: Take notes! Use them to identify biases and action points.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week, it would be Josh Brown’s first-rate warning about the latest round of financial scams. Josh has street cred on helping investors – often by revealing what is going on behind the scenes. I reviewed his book Backstage Wall Street, noting that it would save reader thousands of dollars. I have also often cited his second book, written with Jeff Macke, on several occasions. What he writes is colorful, fun, and always adding to his main theme of helping the individual investor.

This week’s post emphasizes that intelligent and prominent people can be victims. It happens even if you are dealing with a prestigious firm. It can easily happen to you. There are many good points, but here is the conclusion:

Peter Lynch said that “Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves.” If your advisor’s answer to the potential for corrections or volatility is to sell you silly (OP: ahem – stuff) from outer space, then your follow up question should be whether or not he or she gets paid for the privilege of your having bought it.

[Jeff] Sadly, I often see such complicated and illiquid assets in the accounts of new clients, usually after a big commission has already been paid and there is no cheap escape.

Stock Ideas

Barron’s mentions Volkswagen, big U.S. banks, and Southwest airlines as candidates for major moves.

Chuck Carnevale ventures a bit out of his wheelhouse, using his typical valuation methods on a more speculative stock sector – biotech. This is very interesting reading, with plenty of ideas and suggestions.

John Buckingham of the Prudent Speculator has plenty of ideas worth considering.

It is always interesting to compare the results from different research processes and screens. Here is Value Walk’s growth screen for June.

growth-screen

 

Brexit Reprise

  • Brexit selling might already be over. The story is getting boring. This was from Tuesday!
  • Brexit might not really occur. Readers might recall that I predicted this a few weeks ago, suggesting that the referendum result might wind up as a negotiating ploy. It was a Barron’s story this week, and others are joining in.
  • Economic predictions are already suspect. I started to quote the culprits, but decided not to. What is the point. Beware of writing when you are reaching outside of your “happy zone.” The basic economic effects on the U.S. will be modest. Most of the dire predictions relate to falling dominoes, an easy and typical scare tactic.
  • Most investors lost money. (MarketWatch).

MW-EQ606_openfo_20160701114702_NS

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, and I have two favorites this week. The first, from Josh Brown, is reported above. The second is a brief and cleverly-written story by Carl Richards. It is difficult to quote it without spoiling, so please take a few seconds to read it yourself. Here is the Sketch Guy’s chart:

062716bucks-carl-sketch-master768

Kurt Feuerman has a similar story about the news barrage from perma-bears whenever markets turn volatile. It is well worth reading his account of past crises, looking at the charts, and enjoying the picture of a nasty-looking bear. Here is a key quotation:

Right now, for instance, is a good example of when to exert your objectivity. Fear is running high. Along with that, there’s a pervasive distrust of equities. But let’s look a little closer. The yield on equities is roughly 2.2% versus the 10-year Treasury yield of 1.5%. Once again, there’s a mad dash to safety assets, so the rates on Treasuries continue to fall. Yet the current situation actually creates a double positive for stocks: interest rates are likely to stay lower for longer, which helps support equity valuations while also providing investment-grade issuers with the ability to borrow cheaply and increase shareholder value.

Watch out for….

Chasing performance from last year’s best hedge funds. Abnormal Returns takes two successful funds with completely different strategies. Here is how they are now doing:

ALFA2_0616-1024x394

Final Thoughts

I doubt that I can match my “final thoughts” from the last two weeks. I hope readers were helped in weathering another round of macro news with plenty of speculation about U.S. stocks.

The potential trading range I laid out two weeks ago was pretty much on target. The preliminary expectations about the vote led to a larger reaction than would otherwise have occurred. Media milked this for all it was worth, taking the prior Thursday close as the correct starting point, despite the run-up. Just staying cool can be a challenge!

What about a summer rally? It is a good guess about the theme for the week. As is often the case for the weekly theme, I don’t know the answer and neither does anyone else. That said, I rate the possibility higher than most, and therefore another good contrarian play. We have had a long-time tight trading range, so a breakout would be meaningful for many. Rightly or wrongly, much will depend on the employment report.

The economy is the key to future earnings. Recession odds are low, earnings are improving, the oil issue has stabilized, and the Fed is on hold.  Many “trading range worries” are now behind us.

Weighing the Week Ahead: Is the Brexit Vote a Turning Point for Stocks?

This week’s economic calendar has plenty of data during a week where many will want to anticipate the long weekend. Despite these factors, most are still trying to digest the Brexit decision. There will be stories on politics, polling, history, and human interest. The economic and financial market consequences will get the most play from financial media.

Is the Brexit Decision a Market Turning Point?

Last Week

There was some significant economic news, but attention focused on Europe and the United Kingdom.

Theme Recap

In my last WTWA, I predicted that the week would be all about Brexit. Despite Yellen’s Congressional testimony, the Brexit theme was a wire-to-wire winner.

Last week’s “Final Thoughts” section was also on target, suggesting a plausible range for the week’s trading.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the early strength, based mostly on the Brexit polls, followed by Friday’s collapse. Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

 

The Good

  • Hotel occupancy continues at a near-record pace. (Calculated Risk).
  • Fed stress tests were solid. Banks can $526 billion in losses under the “adverse scenario.” (MarketWatch). Bloomberg’s editors have a contrarian viewpoint.
  • Existing home sales were strong. Bill McBride explains that it would have been even better if inventory were not so low. It is a complex story because baby boomers are “aging in place” and some single-family homes were converted to rentals. The numbers do not always reveal the underlying strength. And BTW, mortgage rates are near record lows. The good news was reflected in the Lennar earnings release.
  • Chemical activity is up 3% in the last three months. (Scott Grannis).

CAB 1960-

  • Initial jobless claims dropped to 259K, a great reading. It is important to monitor job creation as well as job losses, so this good news is not the whole story.

The Bad

  • Durable goods orders declined by 2.2%, missing expectations. Steven Hansen examines year-over-year changes in the adjusted data and arrives at a slightly better conclusion.
  • Social Security financing projections got worse, exhausting the funds two years earlier than expected. D-Day is now 2028. Political leaders need to get a compromise solution in place very quickly. The longer the delay, the more difficult the solution becomes.
  • Leading indicators declined 0.2% when a gain of 0.2% was expected.
  • Rail Traffic continues to decline, although the rolling average is a little better. We have been following Steven Hansen’s coverage of this topic (GEI), partly because of the exhaustive analysis of past data. At some point we might see the effects of reduced coal consumption to show up.
  • Michigan sentiment slightly missed expectations with a reading of 93.5. Doug Short has the best representation of the history of the series and the link between sentiment and the economy.

Michigan-consumer-sentiment-index

  • New home sales at an annual seasonally adjusted rate of 551K missed expectations of 560K and decreased from the prior month. Calculated Risk provides a chart of the long-term results.

NHSMay2016

 

The Ugly

Non-working, prime-age men. With varying motives, there is a very misleading and oft-repeated “94 million people can’t find jobs.” While this is technically true, it includes grandma, teenagers, and people who prefer to study or take care of families – among others. A much better group to study is men between the ages of 25 and 54. The White House Council of Economic Advisors released a report examining the long term decline in labor force participation in this group, a trend they call “worrisome.” Various sources have provided summaries of the 50-page report and added commentary. Alan Berube (Brookings) does this nicely, including this chart of areas where the problem is greatest.

prime age employment map

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations are always welcome.

Noteworthy

I enjoy Pandora’s music service, often listening as I write WTWA. I have never owned the stock, but when their CEO appeared on CNBC last week I turned off the mute and TIVO’d back to watch the interview. Among other things, he discussed the potential for targeted political advertising. He stated that they could predict votes with 90% confidence using only two variables: Zip code and Pandora playlists.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a big week for economic data, with many participants edging out the door by noon on Friday. I always highlight only the most important items, helping us all to focus.

The “A” List

  • The ISM Index (F). Important for those on recession watch.
  • Consumer Confidence (T). Good read on employment and spending.
  • Personal Income and Spending (W). Key data on consumer health.
  • Auto Sales (F). Continuing strength in this private data series?
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Pending Home Sales (W). Less direct impact than new home sales, but a good read on the housing market.
  • Construction Spending (F). A noisy series, but an important sector.
  • Q1 GDP (T). This is the final estimate – at least until benchmark revisions. Old news, but it is what goes in the books.
  • More Fed Stress Test Results (W). Which banks can increase dividends and buy back shares?
  • Chicago PMI (Th). Market will watch for a hint about the ISM report.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

Fed Chair Yellen is meeting with ECB President Draghi at a European forum on central banking. That should be interesting! We’ll get some additional FedSpeak later in the week.

Next Week’s Theme

With the momentous Brexit results known, it is time for the pundits to explain what it all means. Despite the daily flow of economic reports, Friday’s stage-setting selloff guarantees that attention will once again focus on Brexit. It is certainly historic, and might provide a tipping point for the UK or Europe.

While the financial media theme for the week ahead will be broader, the key point will be:

Is the Brexit result a turning point for equity markets?

As was the case last week, I read many articles on this topic, watched webinars from experts, and listened to the punditry. (As I write this, I am reminded of the best football preview program. Mrs. OldProf, who grew up in Green Bay is an enthusiastic and knowledgeable fan. She loves the show, and so do I. You have to record it in the middle of the night and watch it on Sunday morning. One of the hosts, Merril Hoge, usually says that he did “70 hours of tape study” in the prior week! The plays he selects to analyze provide some credibility for this claim).

Since I read quickly, I did not spend 70 hours on Brexit. I did read a lot more than you probably want to. In this week’s WTWA I want to cover a range of key perspectives. Read some of these links, the best and most responsible samples of each type, and draw your own conclusions. Then check out mine at the end of this post.

  • Every market was rocked, or hammered – but maybe not a Lehman moment. CNBC kept running the “Markets in Chaos” subhead. The WSJ coverage was more moderate than most, but it will still worry most.
  • Expect more volatility. Beware! (Oppenheimer)
  • Brexit is bad for U.S. companies and corporate profits. (Barron’s)
  • Expect a decline in UK GDP. Econbrowser summaries key studies.
  • Expect weakness in the global economy. (The Atlantic).
  • The process will lead to more uncertainty and pain. (Hale Stewart at Bonddad. Also here and here. Further thoughts from his colleague, New Deal Democrat).
  • Cameron has sent the UK into a “potential investability vacuum.” (Reuters BreakingViews)
  • The voting “disaster” will lead to the breakup of the UK. (Reuters BreakingViews)
  • The result may affect U.S. consumer confidence and the 2016 Presidential election. (Benn Steil via GEI)
  • Voter remorse from Brits who did not understand? Google searches raise the question.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Indicator Snapshot 062516

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

This week the recession odds (in nine months) have nudged closer to 10%. This does not completely reflect Brexit effects, so we may get a further revision.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update describes the elements of the indicator we cite every week.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation. Dwaine’s most recent update, U.S Economy most vulnerable to any shock since 2008, shows the recent deterioration in conditions. Read the full post, but the two charts below show the decline of the long-term leading indicators despite continuing low odds of an imminent recession.

2016-06-24_1315

2016-06-24_1334

 

 

As we review the weekly indicators it is important to maintain perspective. A 20% chance of a recession would be average. It is not a reason for fear, since it says that a recession is very unlikely. There will be a time to exercise more caution, but we are not yet close to that point.

I know that some readers have wondered whether the needle was “stuck” on these indicators. There is a temptation to tap on the gauge to see if it moves! We are seeing a little movement this week after a very quiet stretch.

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 could be the Year for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions or suggestions for new topics.)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested in fairly aggressive choices. This was good for most of the week, but bad on Friday. The more cautious Holmes is still fully invested, but fared better in Friday trading. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

Brett Steenbarger once again challenges traders. What can you learn from this?

Bergen poster

 

His crisp analysis shows why it is important to be unique, and also how to do it successfully.

Dr. Brett’s Brexit advice emphasizes the difference between novice and expert traders.

Josh Brown explains how to use the VIX in your trading. There are very good results from watching VIX spikes during an uptrend. (See also Dana Lyons). Many investors take the opposite viewpoint about the “fear gauge.” Maybe that is why it works so well. Maybe it is related to what Dr. Brett is saying!

Why do traders blow out? One reason is “revenge trading.”

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read, it would be this analysis from “Davidson” via Todd Sullivan. This is extremely important and worth reading carefully. Twice if you need to. He takes on the basic issue of why most analyses of value and momentum methods are wrong, introducing what he calls the 1% solution.

A key point is that value investors have great influence on markets:

The long-term perspective reveals that SP500 Index has grown ~6.1% in line with long-term earnings. Value Investors perform contextual analysis to determine at what price they find long-term value in markets. The period 1965-1982 was a period of SP500 underperformance relative to earnings. Rising inflation caused Value Investors to contract P/E levels.

Screen-Shot-2016-06-21-at-12.33.27-PM-768x492

 

From the SP500 EPS & P/E’s 1871-May 2016 chart, it appears we may be near a market top, but Value Investors today indicate this is not the case in their experience. Explaining why Value Investors are likely to be right requires contextual analysis which many do mentally. Warren Buffett’s now famous saying, “My brain is a computer” explains why this is so.

He provides a lot of additional explanation and detail, concluding:

Be patient. Several years of economic expansion appear to be ahead of us. I expect investors to shake off the current pessimism and shift equity markets higher. Investment success relies in having realistic expectations and being grounded to fundamentals.

(At some point several years from now, the economic data should indicate that an economic correction is likely. I will then recommend an appropriate shift in strategy. But, not today!!)

[Jeff] This is very strong and exactly right for investors.

Stock Ideas

Airlines benefiting from Brexit? Raymond James provides some ideas. (via Barron’s)

Ben Levisohn asks, Biotech: Buy the Brexit Blowup? His sources suggest that the selling greatly exaggerates the actual impact on many stocks. Check it out for specific ideas.

How about diversifying by strategy rather than by allocation? Michael Batnick explains how this can both improve returns while reducing risk. (Holmes is vigorously wagging his tail in agreement).

Tesla. Really? Every big firm hates the deal to buy Solar City and has downgraded the stock. One contrarian source likes the underlying numbers and notes the potential that the deal would be withdrawn. That was our thinking when we initiated a small option position. This is the kind of situation that can provide a great risk/reward ratio, but not by just buying the stock.

The Hardest Question: When to Sell

Chuck Carnevale wisely notes:

The most common complaint that I have heard from investors over my 40+ years in the financial services industry is as follows: “Everyone wants to tell me what to buy and when, but no one ever tells me when to sell.”

Hint #1: Do not sell just because the price drops.

Hint #2: Keep the stock’s fair value in mind.

Read the full post for plenty of helpful analysis and examples.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is Morgan Housel with (yet another) great piece. It is aimed at new grads (although nearly everyone could benefit). He asks various sources for their best advice in five words. There are plenty of good ideas here, even though he allows four more words of advice than Dustin Hoffman got.

What would I say? How about: Don’t spend all at once. Well that was what my son calls “dad humor.”

My own father had great advice, and it did not take five words: Always think of tomorrow.

Runner up? This analysis of the 30-year mortgage, which might cost buyers an extra $100,000 or so, just so they can reach for more than they can afford.

Doing your own work?

If you are a serious individual investor making your own decisions, you should monitor your stocks via Seeking Alpha’s excellent transcript service. You can also get a lot of information from Avondale Asset Management’s weekly summary.

Final Thoughts

 

There is an important distinction among various Brexit effects: politics, history, economics, and markets. If we were sitting down for a cup of coffee or a beer, I would discuss any of them. As investors we should be mainly concerned with the last, and perhaps a bit with the economic effects.

That will be my focus.

The Path Mattered

The five-day path to the final decision was very important. The range of the week’s trading was within the +/- 2% we cited last week. The week started with a rally when markets mistakenly thought that the “remain” vote would prevail. When the opposite occurred, the market gave that gain back and declined another 1.3% or so. Everything was within the range that we expected.

  • If you kept this in mind, the big selling on Friday was not a surprise.
  • The path set up a big news event – markets in chaos, stocks slammed, Brexit threatens world economy, etc. Suppose that the vote had been on Monday, before the run-up. A decline of 1.3% would have been a relatively normal reaction to some negative news – not a catastrophe.
  • The psychology is in place. The weekend news coverage will frighten individual investors, probably leading to a weak day on Monday.

Most Fears Are Speculative

The measurable effects are all modest.

The biggest negative impacts all relate to speculation about the effect of uncertainty.

Investment Implications

As is often the case, the best risk/reward for investors is contrarian.

  • Allow markets to digest the Brexit information and don’t panic; (Morgan Housel and also MarketWatch)
  • Ignore those pitching a personal, political, or product agenda;
  • Emphasize quantitative fundamentals. Earnings impacts may be exaggerated; (Brian Gilmartin)
  • Choose value stocks;
  • Do not overreact to headlines calculated to sell advertising; (Chuck Jaffe, MarketWatch) and finally
  • As I noted last week, this may not be the final chapter. (Bloomberg)

Read these sources carefully and contrast with the more speculative fears.

The most difficult thing for most investors is to “stay the course” in the face of frightening news and incessant recession predictions. It is also the most rewarding.

Weighing the Week Ahead: The Fed, Brexit, and the Markets

This week’s economic calendar is back to normal, with Wednesday’s FOMC announcement the highlight. Last Friday’s trading put the Brexit effects on the front burner, so I expect two themes for the week ahead. The first few days will be all about the Fed and any hints about the pace of rate increases. After the Fed meeting the emphasis will shift to the Brexit build-up, culminating next week.

Expect some punditry magic. The regular Fed experts will morph into Brexit gurus by Thursday morning!

Last Week

There was little economic news. What we had was encouraging. Once again, markets were pretty firm—until Friday!

Theme Recap

In my last WTWA, I predicted plenty of attention to the weak employment report and the implications for stocks. That was a pretty good guess for the early part of the week. There were some who joined me in noting the problems with this report and also plenty who created those “rolling over” curves that are so popular. Every day there was another story from a big-name trader or manager expressing concern about the weak global economy. (More on that topic in the Investor section below).

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. You can clearly see the quiet market, at least until Friday! Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

 

The Good

Households Balance Sheet

 

  • Consumer sentiment from the Michigan survey remains solid. The Doug Short chart (via associate Jill Mislinski) has a great combination of history, the GDP relationship, and past recessions.

 

Michigan-consumer-sentiment-index

 

The Bad

  • The rail contraction is getting worse. Steven Hansen (GEI) has the update.
  • Brexit odds increased. A poll showed a big shift, with a ten percent lead for the “Leave” faction. The immediate reaction was the this (questionable) chain: lower pound à lower Euro à stronger dollar à lower commodity prices à implication of slower growth à RISK OFF!!
  • Downbeat economy makes June action by the Fed unlikely. Our go-to Fed expert, Tim Duy, looks at the data in the wake of the employment report. He also provides a Fed preview, highlighting labor conditions.

-1x-1

 

The Ugly

The candidate reaction. I have seen many elections where people were unhappy with the choices, but nothing quite like this. 10% of homebuyers say they will consider moving if their candidate loses. It is probably an exaggeration, but still an interesting reflection on the times.

 

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to New Deal Democrat at the Bonddad Blog. Not only did he take on an extremely popular and deceptive chart, he put the research together and reacted in a timely fashion. Here is the bogus chart:

blogger-image--1828015261

 

The chart quickly spread as the “Doomer graph du jour.” I saw it on several sites. There is widespread lust for “evidence” of a new recession. Charts like this are frustrating – so many misleading stories, so little time.

The Silver Bullet winners should get appropriate and timely recognition.

As is often the case with these bad charts, the original author does not provide either data or sources! Everyone who wants attention and confirmation bias republishes the chart. NDD demonstrates that the timing of the recession calls is completely wrong if one accounts for the actual availability of the data. This is a common amateur blunder.

I encourage you to read the painstaking efforts to reconstruct and explain the data at Bonddad and also Matt Trivisonno’s blog.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a fairly big week for economic data and news. I highlight only the most important items, helping us all to focus.

The “A” List

  • FOMC rate decision (W). The Yellen press conference will get close attention.
  • Housing starts and building permits (F). Will the rebound continue?
  • Retail sales (T). Of special interest in the wake of weak earnings from some retailers.
  • Industrial production (W). A highly volatile series, but important.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • CPI (Th). Inflation is not getting much attention. It will take a few hot reports before this regains significance.
  • PPI (W). See CPI above.
  • Business inventories (T). April data, but relevant for Q2 GDP.
  • Philly Fed (Th). One of the two regional surveys that has some market impact.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

Beyond the FOMC meeting itself, there is no FedSpeak.

Next Week’s Theme

 

It is a rather normal week for economic data, with the FOMC announcement on Wednesday at the highlight. I expect the Fed to be the focus for the first part of the week, with attention shifting to Brexit on Thursday. Next week will feature an even larger Brexit focus. We therefore have a twin theme:

Will the Fed signal any change in the pace of rate increases?

Will the Brexit odds change, and what are the implications?

There is little to add on the Fed issue, which is probably the most over-analyzed in history.

Concerning Brexit, we have three questions (at least):

  1. What are the odds of the June 23rd vote? The most recent poll shows a 10% bulge for Leave, but the bookies do not really endorse this.
  2. What are the issues? It is helpful to understand both the facts and what people believe to be at stake – things like immigration, membership costs, trade relationships, impact on health care, and availability of employment. Does any of this have a familiar sound? Putting aside whatever opinion you might have, what are the implications?
  3. What are the Brexit consequences? For Britain, for Europe, and for the rest of the world?

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Indicator Snapshot 061016

 

The Featured Sources:

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he expresses more confidence about growth in earnings.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). Monthly reports including both an economic overview of the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. His latest update features his unemployment rate recession indicator. A recession is unlikely “any time soon.”

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

 

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. You can still follow them via Doug Short and Jill Mislinski. Their commentary remains bearish despite the upturn in their own index. While no one really knows what is in the black box, I suggested years ago that they incorrectly emphasized too many commodity series, falling victim to multi-colinearity. Commodity prices fooled them in 2011. Now they seem to be ignoring the rebound.

Big-Four-Indicators-Since-2009-Trough

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (Please send any questions or suggestions for new topics.)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested, but the sector balance has become more conservative. Most sectors remain in the penalty box. The (usually) more cautious Holmes is almost fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now. It is not a resounding endorsement of the overall market, but a vote for opportunistic trading.

Top Trading Advice

 

Anora Mahmudova (MarketWatch) exposes a deceptive chart pattern – the head-and-shoulders. I am interested in hearing from traders about this, but these complex charts seem open to misinterpretation. We rarely hear about failing setups.

Pradeep Bonde has some good advice for improving on a daily basis. He notes that it takes five years for traders to develop the needed skill.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read, it would be a split decision. There is plenty of dangerous and deceptive information about the alleged warnings of big fund managers. Some of these were incorrect, while others were just misleading. In one case the always-bearish prognosticator, Mr. Dow 5000, cannot decide if the Fed has engineered deflation or hyper-inflation. (A supernova can either implode or explodes, he explains). It is all going to blow up somehow, so you should own his bond fund instead. OK….

Here are some helpful articles. If you read them, you will have some inoculation against hype.

  • Ichan is out of Apple while Buffett is in. Valuation guru Aswath Damodaran looks at time frames, methods of analysis, and the perspective of traders versus investors. It is tough work for most readers, but if you want to make good decisions as an individual investor, you need to understand this.

AppleIcahnBuffetteffect

 

As well as the entire process —

Price vs value simple picture

 

  • Soros reports related to his family office. We don’t know why or when viewpoints might change. (Josh Brown)
  • Soros has (supposedly) been wrong on many prior “turning point” occasions. (Cullen Roche)
  • And last, but I hope not least, I have demonstrated that government filings are completely worthless. Because they do not report short positions, you only see a part of each trade. This is especially bad on option positions, where the media report long positions in puts (a short instrument) without description of the entire spread. The notion that being short a put is actually a long position in the underlying befuddles nearly everyone. Even the most prominent media sources provide absolutely no help on this subject. Instead the reporters are assigned a story about the Soros put holdings. My multiple articles on this have not gotten much attention, despite the careful research and examples.

Stock Ideas

We have some diverse suggestions this week.

Think outside the box with James Altucher. He brainstorms on how we can profit now from something we know is coming: the driverless car. This fits my definition of something you will not read about in tomorrow’s paper.

I tried to provide another example (Finding the Best Contrarian Stocks), answering some reader questions from last week about why I preferred banks to utilities.

Sometimes you know the theme from current events, but you might not know the best stock play. I am not a big fan of anonymous authors, but sometimes follow them until I am convinced of the quality. Valuentum explains why Palo Alto Networks is more attractive than one might originally think. Hint: free cash flow. We reached the same conclusion a few weeks ago.

Sector Ideas

Energy prices have been less wild, which is probably good for investors. Some experts are even picking up my recent theme that $50 oil may be something of a barrier, with current prices representing a “sweet spot” for the economy. Oil Insider asks, Have Oil Prices Hit the Sweet Spot? (subscription required, but here is a key chart).

92d34a40-10f3-45ea-b190-fbd2753d56d3

 

Anyone interested in energy eagerly awaits the annual Statistical Review of World Energy from BP. Here is a key summary chart:

BP Oil Consumption and Production

Housing has been one of my favorite themes this year, and it got plenty of attention this week.

  • Housing is “eating the economy” says Conor Sen. Here is a key part of his case for further expansion:

    One way to show how much more growth housing, and construction more generally, has in front of us is to look at construction’s share of total employment. It’s currently 4.6%, and in every cycle ever it’s gotten to at least 5%. Given 1) the size and hence housing needs of the Millennial generation in years to come, 2) the lack of construction, of single family especially, since the financial crisis, 3) the potential for infrastructure spending from the next president, whether it’s the Hillary/Dem version or the Trump “build a wall” version, 5% seems like a reasonable conservative target for how high this will go over the next 3-5 years.

    tumblr_inline_o8axtpc21f1rufy3f_500

     

  • Ben Carlson asks, Has There Even Been a Better Time to be a Homebuyer? After describing interesting data showing the difference between today’s houses and those built in 1973, he summarizes:

    Houses today also have wireless Internet connectivity, better appliances, and are generally more energy efficient. They aren’t making enough of them in my estimation — and I may be stating the obvious here — but new homes today look better, have more features and are higher quality than those built in the past.

    To summarize — houses today have fewer people living in them with more space, more bedrooms, more bathrooms and more comfortable living conditions.

    But wait…there’s more.

    Mortgage rates are at record lows:

    Screen-Shot-2016-06-06-at-11.16.55-AM

  • Ivy Zelman, a leading housing expert noted for frank and accurate analysis, did an interview with Barron’s. Here is a key quotation:

    Barron’s: April new home sales soared 17%. Where are we in the housing recovery?

    Zelman: Four years in. The first increase was in 2012. There are multiple years ahead. We are still 35% below a normalized level of starts, and that’s for a single-family. Every cycle is different. This cycle will be elongated, and the slope of the recovery is flatter than what we thought the trajectory would look like when we called the bottom in 2012. Builders have been slower to see the growth. There’s a shortage of shelter. We’re pretty indifferent whether shelter should be owned or rented. We’re just saying there isn’t enough. The U.S. is at a 30-year low of inventory available for sale. We are predicting double-digit housing-starts growth this year, next year, and in 2018.

    The interview includes a number of stock ideas, including two which we own (LEN and CAA).

  • Robert Shiller (via Mark Thoma) says that fears of being priced out of housing are “overinflated.” In analyzing fears based upon quite different factors, Prof. Shiller wonders, “(W)hy do people still worry that home prices are getting out of reach? The answer can’t be found in the housing data”.

Biotech is worth a look.

  • Charles Pennington notes the long-term success of biotech, using the Fidelity biotech fund as evidence. A better buy than in 1988?
  • Chuck Carnevale has five candidates for consideration. As always, he carefully notes which stocks might be better for a given investment objective. And of course you get a master class in using the F.A.S.T Graphs method. Here is one chart for one example. You need to read the entire post to appreciate the depth of the analysis.

     

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Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is an article from Morningstar’s Russ Kinnel, 20 Common Investing Mistakes. It is a nice analysis of how emotions interfere with decision making and the need for planning. Here are two of my favorites, both very common:

Mistake 2 | Basing sell decision on cost basis.
You bought fund A at $10 and now its net asset value is at $5. You bought fund B at $10 and now it’s at $20. Which should you hold, and which should you sell? I have no idea. The amount you paid is relevant only to tax planning. What matters is which will have better returns over your investment horizon. If the answer is fund B, then sell fund A (you’ll have a tax benefit if it’s in a taxable account) and put the proceeds in fund B. The problem is that people have an emotional attachment to the price. Some are afraid to book losses, and others are too anxious to sell a winner for fear that they’ll miss out on gains. What matters is whether the funds have strong fundamentals.

Mistake 17 | Misreading your own abilities.
People who treat gambling addicts say that it’s the big winning bet that hooks gamblers. They get high and want to repeat that high. Fund investors can be a little like that. They remember that one time they accurately called the direction of the market or picked a sector fund, and they forget all the times their calls were off. Go back over your past investments. See what you do well, and figure out a solution for the areas where you didn’t do well. Maybe your individual stock picks aren’t that great overseas, so you should buy a foreign fund. Maybe your bond fund blew up, so you should change the way you pick bond funds and tone down the risk.

I try to include good advice for young investors, but there is a real shortage of material. MarketWatch has seven good tips for those in their 30’s. Many boomers wish they had known these when they were younger!

Watch out for….

Hedge funds (and similar opportunities). Rachael Levy explains, The secret to investing in hedge funds.

Cambridge Associates is one of the biggest investment consultants advising pensions and others on which funds to choose.

Their secret to picking hedge funds: avoid almost all of them.

“We think about 5% of the entire universe could be on a list of potential funds to look at,” Joe Marenda, a managing director at Cambridge, told Business Insider.

 

Final Thoughts

 

There could be a lot of volatility this week – important for traders, but pretty meaningless for investors. At least for those who keep their heads.

I expect nothing meaningful from the Fed meeting, but that will not stop the punditry. There will be massive efforts to infer something.

The Brexit story will include updated odds and I expect it to be the theme next week. I have no special insight about how this will turn out. I am watching my sources closely, especially concerning the possible economic impacts. I was accurate last week in noting this has something to watch, but no one really has a good handle on the implications.

Traders can try to guess the outcome and the reaction. Investors should approach the week ahead with a shopping list. Get ready to take advantage of opportunities. In this WTWA I tried to provide special emphasis on stock ideas. I hope it will provide some ideas for your own research.

Finding the Best Contrarian Stocks

Why does everyone want to be contrarian? It is the best way for long-term investors to beat the market. You can be a trader of popular momentum stocks, but you need to be agile in your timing.

Contrarian investing is rewarding for investors with discipline and the right temperament. Here are four rules:

  1. Forget about what you read in the newspaper or see on financial television. This is what we call “old news.” People who appear are attempting to sound smart by telling you things that reinforce what you already know.
  2. Find a theme that is difficult to see. Contrast it with something that is easy to see.
  3. Look for the best (or worst) ETF choices for these themes. Single out the best (or worst) stocks in the sector.
  4. Verify your analysis with data!

A Current Example

Often, the best way to explain an idea is to provide examples. Let’s repeat the four points above with our examples in mind.

  1. There is a daily media assault on banks. Government regulation is reducing profits. The yield curve is too flat. Energy companies might go bankrupt, and reserves might be too small. It is going to be 2008 all over again. [Old news – and also inaccurate].
  2. The long-running quest for yield has induced investors to focus on dividend yield rather than the strength of the underlying investment. The yield is easy to see. The risk is not.
  3. The financial sector is attractive; utilities are not. Focusing on regional banks permits you to avoid some of the government attention to big banks and also minimize energy exposure. The regional bank ETF (KRE) is a good choice. By contrast, very bad sectors should be on your “sell” list. Utilities have rallied strongly in the reach for yield. The XLU ETF is the popular choice in this category, having risen to over-valued territory.
  4. We can now pick some attractive trading candidates. Due diligence starts (but does not end) with a trip to F.A.S.T. Graphs. Depending upon the stock and sector, you may need to dig deep. F.A.S.T. Graphs has plenty of additional information, but check out other sources as well.

Since economic growth is under-rated and interest rates are likely (finally) to move higher, my long and short candidates both reflect this.  Most people do not realize how far the quest for yield has stretched the valuations for utilities.  Meanwhile, banks are hated.

We investigated regional banks, looking at factors like tangible book (important for banks and hard to find) and identified several for our basic stock program. (I was not surprised when a leading investor was interviewed on CNBC, mention six banks out of hundreds. Our three choices were on his list). One pick is KeyCorp. Earnings growth is 16% and the multiple is below 12. Meanwhile, you collect a dividend of 2.7%

KEY

While we do not do short selling of individual stocks or ETFs in our programs, investors should be worried about utilities, including XLU. Check out the stock that represents almost 9% of the ETF —   NextEra Energy (NEE) The stock has an earnings growth rate of about 6% and a P/E of 20. The yield is 2.9%, only slightly higher than our regional bank example.  It is like owning a 100-year bond.  Owners will get crushed by a modest increase in interest rates, as the stock price falls to maintain a yield differential over Treasury notes.

NEE

 

Conclusion

Contrarian investing is not easy. You will not hear the TV pundits praising your stocks – at least not at first. You also would like to have a catalyst that will change the public perception. In this case, a small increase in interest rates will start the ball rolling.

Only the greatest succeed in spotting where the puck is going. That is the challenge. If you aspire to beat the market, you need to think ahead!

Weighing the Week Ahead: What is the Risk/Reward for Stocks?

This week’s economic calendar is loaded, and packed into a holiday-shortened week. There will also be plenty of FedSpeak, encouraging the favorite game of not just reporting data, but wondering how the Fed will see it.

When it comes time to put it all together, pundits will be asking:

What is the risk/reward tradeoff for stocks?

Last Week

The news was very good, and the market responded.

Theme Recap

In my last WTWA, I predicted that the pundits would be focused on the oil price rally and what it meant for investors in stocks. That was a good call, with the theme continuing through week’s end. Several sources even cited both the recent strength and the apparent ceiling at $50/barrel. As a bonus, the strong housing data revived the “springtime for housing” theme from two weeks ago. Despite the competition from election news, these were important stories. If you prepared in advance, you were better able to handle the news.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The most important economic and market news was quite good.

The Good

  • Q1 GDP was revised higher, up 0.8% instead of 0.5. This is old news, but it does provide a slightly stronger base for the year. More importantly, the current data suggests that Q2 will be much stronger – some estimates now reaching 3 %.
  • Jobless claims declined again, to 268K. People are not losing jobs, especially when considering the higher working population. We also need job creation. Bespoke has the story, and a great chart.

     

052616-Initial-Claims-SA

  • Industrial production jumped 5.8%, the most in eighteen months. Utilities were behind much of the gain.
  • The Michigan sentiment index showed a surprising increase of 5.7 points, for the highest reading in nearly a year. Jill Mislinski provides a complete analysis and Doug Short’s chart. You can readily see that the index is back at healthy levels, topped only by the Y2K era.

Michigan-consumer-sentiment-index

 

  • Housing data showed real strength.
    • Pending home sales popped 5.1%. (Calculated Risk)
    • New homes sales had the best showing since 2008. Inventory is now down to 4.7 months. (Calculated Risk)

NHSApr2016

The Bad

  • April durable goods fell 0.8%, worse than expectations of a 0.3% decline. (BI).
  • Transportation “stunk in April” according to New Deal Democrat. It has certainly been the worst part of the economic story. Check out the full post for details. Steven Hansen at GEI has a thoughtful analysis suggesting that this was a “huge recession which never came.” Think about coal.
  • Puerto Rico debt measure is stalled in the Senate after progress in the House. This represents more than the specific issue. It is something of a litmus test for Speaker Ryan’s ability to negotiate. That is the real market significance.

     

The Ugly

The vulnerability of government technology. The multi-year pressure on government spending has had a definite effect on equipment. Upgrades that would be routine in business simply do not happen in government. It is a vicious cycle. The older the equipment and software get, the higher the maintenance costs. Barbara Kollmeyer has a good analysis of the problem, including this chart.

MW-EN838_gao226_20160526041302_NS

This problem is deeper than general obsolescence. The determined hackers are looking for vulnerable systems. There is a likely collision course, already seen in prior attacks.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger. This week’s award goes to Narayana Kocherlakota, former President of the Minneapolis Fed. Many of those who have moved on from a roles as official participants in Fed meetings are speaking out. This valuable information gives us an inside look. Sometimes the message is that we are making too many unjustified inferences. Kocherlakota writes:

Timing alone, though, hardly merits so much attention. To understand why, consider two possible scenarios. In one, the Fed starts raising rates in June and then adds another quarter percentage point at every second policy-making meeting (once every three months) for the next three years. In the other, the Fed waits until the second half of 2017 and then adds a quarter percentage point at each of the next 12 meetings. The second path represents slightly easier monetary policy, but most economic models would suggest that there would be almost no difference in the effect on employment or inflation.

It is possible that no information will be more important for investors over the next two years or so.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a very big four-day week for economic data. (Dare I say YUGE?) I highlight the most important items, helping us all to focus.

The “A” List

  • The employment report (F). Remains the biggest news of all.
  • ISM index (W). Great read on an important sector. Concurrent with some leading qualities.
  • Personal Income and spending (T). April data, but a continuing rebound here is important for economic expansion to continue.
  • Auto sales (W). A strong indicator of economic growth. F150 sales? Many believe this is linked to construction and small business.
  • Consumer confidence (T). This is the Conference Board version. It provides information on job creation and spending plans that you will not get elsewhere.
  • ADP private employment (Th). This independent read on private employment growth, using contemporaneous data, deserves more attention.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Fed Beige Book (W). The anecdotal report that will inform participants at the upcoming Fed meeting will not tell us much, but pundits will find something!
  • PCE prices (T). The Fed’s favorite inflation measure. Not much change expected.
  • Construction spending (T). Volatile April data is still relevant because of the importance of this sector.
  • ISM services (F). Not quite as important as manufacturing, but only because the data series is shorter. Will recent strength continue?
  • Trade balance (F). April data relevant for Q2 GDP calculation.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

Not much will be happening at the start of the week, with many slow to return from a long weekend. Expect volume to pick up.

There is also a full slate of Fed speakers, including Chair Yellen.

Next Week’s Theme

 

It is a big economic calendar and a holiday-shortened week. There will be a trifecta of questions:

  1. Economics. Will the recent data rebound continue?
  2. The Fed. Will strong data increase the pace and timing of rate increases?
  3. Stocks. How will stocks react? Will good news be good?

The pundits will circle around these topics. Even the pundit-in-chief seems to be shifting with the winds. They will analyze the data, emphasize how important Friday will be for the Fed, and wind up asking:

What is the risk/reward tradeoff for stocks?

 

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

Indicator Snapshot 052816

The Featured Sources:

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he observes that more people are using forward earnings, and many are thinking about 2017.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). Monthly reports including both an economic overview the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Noteworthy this week:

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (Please send any questions or suggestions for new topics.)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is fully invested, and with more aggressive sectors. Most sectors remain in the penalty box. The (usually) more cautious Holmes is once again fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates. That is what we see now.

Top Trading Advice

Dr. Brett Steenbarger emphasizes emotion-free trading. He writes:

The emotionally intelligent trader can prepare for frustration, fear, greed, and other seemingly disruptive states.  By anticipating them, rehearsing our response to them, and channeling their energy constructively, we turn our experience into a powerful trading asset.

Holmes is barking enthusiastic agreement, and Felix is nodding wisely!

12 good points from Paul Tudor Jones (via New Trader U). They are all worth considering, but my favorite is #9:

“Always think of your entry point as last night’s close.”

 

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read, it would be the overall market outlook from David Templeton at HORAN Capital Advisors. He covers many of the themes I regard as most important, but readers will enjoy getting the message from different sources.

In particular, he deals with the common argument about good news: The Fed will raise rates. He writes as follows:

Historically though, the initial moves in rate increases by the Fed is pursued to get rates back to a more normal level. As a result, when interest rates are increased from a level below 5% stocks tend to rise. In short, below the 5% level there is a positive correlation between interest rates and stocks.

correlation rates market

Stock Ideas

Chuck Carnevale has a terrific follow-up to his prior article on Emerson Electric (EMR). Individual investors who do their own stock picking should read this carefully. Not only does he provide great analysis and advice about entry points, it illustrates what your research should cover.

Time to buy Europe? Jason Zweig (WSJ) recounts all of the bad news, as well as the depressed stock levels. Is it time to “buy low?”

And for income investors – always consider the dividend kings. Here are eighteen companies that have increased dividends for at least 50 years. If that level of income is enough, this kind of stock may be the answer. Philip Van Doorn (MarketWatch)

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are always several great choices worth reading, but my favorite this week is from Ben Carlson for his discussion of Social Security Benefits. Here are but two points from a great post. You should read it all.

  • Social Security is a more important part of retirement than many realize, covering more than half of the needs for most people.

Screen-Shot-2016-05-09-at-9.35.14-AM

  • Waiting longer for benefits generally helps, if you are able to do it.

Screen-Shot-2016-05-20-at-4.19.39-PM

The article also has some links to good sources. Your financial advisor should be considering the Social Security contribution when figuring out your retirement needs and asset allocation.

Older investors pick their biggest mistake – not starting early enough in saving for retirement.

Value Stocks

How about AbbVie as a retirement holding? Looking at the numbers shows value, but perhaps no immediate catalyst. Where others see “value trap” I see an opportunity for enhancing good dividend yield by selling near term calls. Take what the market is giving you!

Energy Stocks

There is not a specific recommendation here, but the information is important. I am watching it, and so should you. What companies begin to profit at various levels of oil prices? (The Daily Shot)

5731ace1-a511-4e58-90cf-70fe183dad33

Watch out for….

Safety stocks. Seth Masters asks, Are “Safety Stocks” Truly Safe? Many of the relevant sectors have been part of the recent quest for yield. With investors fearful about a weak economy – or even recession – something with a dividend yield looks great. If the economy improves, it is a different story, as this chart shows:

 

w1056

Bonds. In the “man bites dog” department, even Bill Gross is going negative on bonds. Mr. Dow 5000 is still not recommending stocks.

 

Final Thoughts

 

The risk/reward debate includes many viewpoints, but the worries usually dominate.

  • These stories are more newsworthy, so they get higher ratings. Barry Ritholtz has a good article on “click bait.” One of his examples is the repeated story about George Soros buying puts. I have two different posts (here and here) showing the error of this approach, but the scary stories get the readership.

1200x-1

 

  • The negative predictions call for extreme outcomes (market 50% over-valued – various sources, we are already in a recession – Peter Schiff’s claim this week, Europe and the rest of the world will crumble, or maybe it will be China. There is just enough plausibility in the arguments that many people are “scared witless” (TM OldProf euphemism) If you think the downside is 50% and the upside only 2%, what would you do?
  • The positive arguments are generally modest and restrained. Ed Yardeni (who also accurate downplayed the recession worries in January) sees a 10% upside for stocks in the next year. The Fast Money gang acted like he was crazy. “What needs to happen for that?” was the question. Not much, he explained. A little earnings growth, no recession, and a little inflation. It was a modest claim.
  • Politicians of all stripes find it useful to highlight dissatisfaction. This political approach is effective when running for election, but it is dangerous for investors. It is easy to think about societal ills rather than improving your investments. You cannot improve public policy by making poor investment decisions and losing your money!

For a change, why don’t we ask what could go right? (The Barron’s cover story this week is on the right track, repeating some of our main themes — but perhaps not analyzed as thoroughly. It is always helpful to have more voices helping investors).

  • The economy is not headed for recession, and actually shows promise on the big-purchase items like autos and homes.
  • Employment is good and improving.
  • Earnings may have troughed with the energy crash (apparently) behind us. Meanwhile, energy prices remain relatively low.
  • Interest rates remain low – this makes companies more profitable and stocks more attractive.
  • The dollar strength seems to have leveled off, helping the earnings of multi-national companies.
  • Economic and market cycles do not die of old age. A “mature” cycle has the same survival potential as a new one, despite the appealing metaphor of the doddering old person.

The market could easily gain 10% next year, and the year after that. Picking value stocks could increase your potential, since the economic skepticism has created recession pricing.

Most do not understand this key point: We could be having the same debate two years from now! Or even three.

And stocks could be 50% higher.

Weighing the Week Ahead: How Should Investors React to the Oil Price Rally?

This week’s economic calendar is pretty light. Market participants will be looking to an early getaway for the long weekend. While there will be plenty of entertaining FedSpeak, I expect a different topic to be at the fore. Pundits will be asking:

Should investors react to the oil price rally?

Last Week

The news was pretty good, but the stock market was not.

Theme Recap

In my last WTWA, I predicted that the punditry would be asking whether it was “springtime for housing”. That was the recurring topic as housing news was reported on several different days and garnered plenty of discussion. Competition came from the Fed Minutes, some dramatic earnings reports, and the election race.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. He has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective.

SPX-five-day

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The economic and market news, on balance, was pretty good.

The Good

  • Housing starts increased to a 1.172 annual rate, beating expectations. Calculated Risk has a complete analysis. I am especially interested in single-family building permits, a good leading indicator. Bob Dieli’s monthly economic report always updates this chart:

Dieli Building Permits

 

  • Existing home sales were up 5.45 million (SAAR), the top of the Calculated Risk range for a solid report. Bill writes:

    Note that January and February are usually the slowest months of the year and March and April are the beginning of the “selling season”.  This is a solid start to the year.

    EHSNSAApr2016

  • Jobless claims down ticked to 278K, in line with estimates and below the 300K level that some have been citing. (The four-week moving average was up slightly).
  • Industrial production rose by 0.7%. Eddy Elfenbein has a good report, noting that this interrupts the downtrend since November, 2014. He also points out the effect on the Atlanta Fed’s GDP forecast for Q2, now up to 2.8%
  • Sentiment remains very negative. Urban Carmel summarizes asset allocations and economic skepticism. Ben Eisen of the WSJ cites four stats, including the fund flows in the chart below. Schwab’s Liz Ann Sonders agrees. She notes only negative questions from both investors and advisors, “all almost bordering on Armageddon.”

w1056

The Bad

  • The Philly Fed indexremained negative and essentially unchanged, -1.8 on the diffusion index. Employment improved dramatically, but remained marginally negative. The outlook fell a bit but remained strongly positive. There was little market reaction.
  • Fed minutes showed more chance for a June rate increase. Our go-to Fed expert, Tim Duy, sees a June hike as a bit less than 50-50 but July as quite possible. The Fed remains more confident about the economy than most market participants.
  • LA port traffic declined. Calculated Risk uses a rolling twelve-month average to control for seasonality. The decline was 0.7% for inbound traffic and 0.8% for outbound. Steven Hansen opines that this raises recession concerns.
  • Rail traffic “moves deeper into contraction”. Steven Hansen looks at a variety of rolling averages, including some analysis that adjusts for the declining coal shipments.

The Ugly

State and local pension funds. Chicago provides an example. A decision of the Illinois Supreme Court struck down an “overhaul” of the system, adding $11.5 billion to the deficit, now $18.6 billion. The fund covers 70,000 workers and in the absence of any changes, will run out of money in ten years. (Crain’s Chicago Business)

Noteworthy

Try this financial literacy quiz designed by economists from Wharton and George Washington. (via Shawn Langlois) I am confident that WTWA readers will do well. Keep in mind that less than 1/3 of the population could get all three questions right!

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger. This week’s award goes jointly to Gene Epstein of Barron’s and New Deal Democrat of the Bonddad Blog and xe.com. Both take on the frequent current scary articles about the “flattening” yield curve, citing the yield difference between the ten-year and two year notes. That spread is currently 0.94 percentage points. Those on a mission often cherry-pick the part of the curve to analyze, and cry alarm whenever it gets a little smaller.

Epstein points out that until the curve actually inverts (a spread of less than zero) there is not a reliable recession indicator.

2016_05_23_cmyk_NL_

NDD has a great article with plenty of charts. He calls out the “doomers” with this commentary and chart:

In the last week or so there have been a spate of articles – from the usual Doomer sources but also from some semi-respectable sites like Business Insider vans an investment adviser or two ,see here ( https://lplresearch.com/2016/05/19/is-the-yield-curve-signaling-trouble-… ) – to the effect that the yield curve is flattening and OMG RECESSION!!! Here’s a typical Doomer graph – that draws a trend line that ignores the 1970s and neglects to mention that 2 of the 4 inversions even within the time specified don’t fit:

image_686

I wish that more publications would recognize the Silver Bullet winners and writers like them. It is difficult to call out weak and biased posts. There is little reward for good and courageous analysis.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a modest week for economic data. I highlight the most important items, helping us all to focus.

The “A” List

  • New home sales (T). Continuing strength in housing?
  • Durable goods (Th). Important April data. Continuing recent strength?
  • Initial claims (Th). The best concurrent indicator for employment trends.
  • Michigan sentiment (F). Best for job growth and prospective spending. Strength continuing?

The “B” List

  • Pending home sales (Th). Unlikely to match last month. Not as important as new sales, but a read on the market.
  • GDP second estimate for Q1 (F). This will get attention, but it is old news by now with Q2 more than half over.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

There is plenty of FedSpeak, including a Friday appearance by Chair Yellen. Things will be slowing down by Friday as some slip away early for a long weekend marking the unofficial start of summer.

Next Week’s Theme

 

It is a pretty light economic calendar. In addition to the daily dose of analysis by pseudo-experts on the Fed, I expect to see some serious discussion about energy prices. Will the oil rally continue? What does that imply for investors and traders?

Voting a tentative “No” is Dana Lyons, who cites technical resistance and concludes as follows:

Will the oil rally stop here? We have no idea – but we wouldn’t be surprised to see the rally get clogged up, at least temporarily.

tumblr_inline_o750onwm8P1sq14jh_500

Oil & Energy Insider is also cautious but more bullish, mostly citing fundamentals. Their free edition includes this analysis:

Oil prices bounced around this week, flirting with $50 per barrel but stopping short of that key threshold. The major supply outages in Nigeria (now at 900,000 barrels per day) and Canada (more than 1 million barrels per day) continue to put upward pressure on oil prices as they are erasing the supply overhang. Still, much of that will be temporary. The EIA poured a bit of cold water on the rally this week, reporting a surprise uptick in oil stocks. At the same time, U.S. production continues to slowly erode. The markets are more confident than at any point in recent weeks that prices won’t crash back into the $30s, but more movement to the upside is not a given.

Their premium edition (which requires a subscription) is headlined Fundamentals Starting to Underpin Oil Price Rally. They cover a wide range of considerations, but include key questions: When might we expect Nigerian supply to rebound? Most investors would find their analysis quite helpful:

–    The Niger Delta Avengers have attacked pipelines and platforms in Nigeria, knocking 800,000 barrels per day offline.
–    Between 2006 and 2009 Nigeria suffered a similar level of attacks and outages, and a sweeping amnesty policy helped bring an end to the violence. The new President Muhammadu Buhari has taken a tougher line, ending patronage that existed in security contracts for many militia members, a move that has contributed to the resurgence in pipeline attacks.
–    Nigeria’s cash reserves are running low as its economy slows. Reserves have plunged from $49 billion in 2013 to $27 billion recently.
–    Eni (NYSE: E) suffered the latest attack this week. Fellow oil majors Royal Dutch Shell (NYSE: RDS.A) and Chevron (NYSE: CVX) have also seen their infrastructure taken out from explosions.
–    Nigeria’s oil production is at its lowest level since the 1980s. The attacks show no sign of letting up, and as of now the Nigerian government is unwilling to back down.

 

 

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Risk first, rewards second. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

Indicator Snapshot 052016

The Featured Sources:

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies. This week he observes that more people are using forward earnings, and many are thinking about 2017.

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). Monthly reports including both an economic overview the economy and employment.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting approaches to asset allocation. This week Dwaine opened to the public one of his subscriber-only research reports. He notes that one of his recession indicators has moved up to 60%. He goes on to explain that he uses a group of six different methods as his preferred approach. He writes as follows:

Another way to look at the RFE is to average the current recession probability showing on each of its six model components, which is currently showing a 14.6% probability of recession. This model appears to have served well in the past, with zero false positives above readings of 0.20.

2016-04-26_1743

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Noteworthy this week:

Hedge funds are using artificial intelligence to analyze the Fed minutes. Guess who can do it faster – you or them?

Peter F. Way reports on the hedging techniques of “big money” traders, identifying candidates with the best risk/reward balance. Apple?

501110-14632831049172328

 

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. For most readers, they can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio.
  • Felix and Holmes – top artificial intelligence techniques in action.
  • Why 2016 – The Year of the Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (Suggestions and questions welcome!)

 

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue our neutral market forecast. Felix is about 75% invested, and with less aggressive sectors. REITs and utilities have moved near the top of the list. The (usually) more cautious Holmes remains almost fully invested. Holmes uses a universe of nearly 1000 stocks, selected mostly by liquidity. Even when the overall market is neutral, there will often be some strong candidates.

Top Trading Advice

Dr. Brett Steenbarger has important advice about Seeing Beneath the Market Surface. He writes:

Markets move higher, markets move lower.  The question worth continually posing is, “Is the market getting stronger or weaker?”  This is a meaningful question because a market that moves higher can be getting weaker and a market that moves lower can be getting stronger.

Read the entire post as he explains how to apply this approach.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read, it would be this Forbes article by Brett Steenbarger (and not just because he has some kind words about WTWA, but thanks!) As a psychologist and trading coach he sees things missed by others and explains them very well. I share many of his themes, but often cannot communicate them as well. People need to be open to new ideas and unemotional in executing the plan.

Few can meet these tests.

Stock Ideas

Chuck Carnevale has a timely post on cyclical stocks. He shows how to use his tools to analyze valuation in this difficult sector. When can these stocks be right for dividend-oriented, conservative investors? Emerson Electric (EMR) is his illustration. If you agree with our experts that a recession is not imminent, cyclical stocks are a good place to shop.

How about Kroger? Hale Stewart makes this a good example of how to search for a good stock – find an interesting sector, a cheap stock, and a catalyst.

Retailers that might profit from the “Amazon effect.” (Philip Van Doorn) Hint: they need to change their business model.

Marc Gerstein has some interesting contrarian retail plays. Marc always uses some science in his method. Here he identifies desired characteristics, develops a screen, and looks for a catalyst. It is another article that goes beyond simply delivering stock ideas (although it does that). Stock screening meets Peter Lynch.

How about solar? If energy prices improve, solar stocks do as well. Travis Hoium has an interesting argument favoring First Solar (FSLR) over some alternatives.

Outlook

Why is it so attractive to be negative on your investments? One good answer lies in Morgan Housel’s explanation of volatility and how it can take investors off course. It is so easy to think about an account in terms of how far we are from the past high. In fact, that is the condition over 87% of the time. Each year includes a lot of big moves that seem small when you later look at the long-term stock chart. He uses 1998 as a year of major gains, but only if you were able to ride out the major swings. I like this chart showing time spend below the prior high:

sp6_large

 

 

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in this special edition. There are always several great choices worth reading, but my favorite this week is from Carl Richards at Investment News. He suggests that a good financial advisor helps clients by turning off the news spigot. (If you do not use a financial advisor, I recommend that you turn it off anyway! You might make an exception for WTWA).

There’s a valuable role for us to play as real financial advisers, that of the human curator. Do our clients really need to spend hours sorting through their feeds and trying to decode the headlines or could we be doing that for them? What should they be paying attention to?

For instance, one friend shared with me that when he turned off the financial news spigot, he calculated that he saved two to three hours every night. Do the math and it ends up being a savings of 40 or so days each year.

Value Stocks

Time to buy again? They are cheaper than the broad market and that seemed to be the story last week.

Watch out for….

Boeing (BA). Barron’s warns that demand for fuel-efficient aircraft has declined.

Bonds and fund redemptions. If the ten-year note increases one percentage point, to something like 2.8%, you will immediately lose 9% on your investment. It would take a few years to make that up, even if rates moved no higher.

Investment big-shots using a platform to talk their book. Are they really there to help you? This is an interesting summary of recommendations at the recent SALT conference, which was breathlessly covered in the media. Most of the topics would require a lot of research, but the Sherwin-Williams (SHW) recommendation (You can’t buy paint online) caught my attention. It took about five seconds to discover the error of this assertion.

13F filings. Here is one example that highlights stocks from David Einhorn. This, and nearly everything written about 13F reports is misleading. This WSJ article headlining George Soros is especially misleading. I explained this carefully (for the second time) but no one cares. We can think of it as our secret!

Final Thoughts

Knowing economics helps to understand energy pricing, but the payoff for that knowledge has been delayed. In my most popular article ever on Seeking Alpha, I noted a few basic facts about energy including the relatively small gap between supply and demand. We are now observing the closing of that gap. It could (and will) continue in one of three ways:

  1. Reductions in supply through economic forces. U.S. producers responded, but most others have not – so far at least.
  2. Increases in demand through a growing economy. This is happening with record miles driven in the U.S. and many new consumers worldwide.
  3. External shocks, through weather, disasters, or war.

The same economic effects may well push against a price increase. The reduction in rig counts, for example, seems to have paused for the first time in eight weeks. Bespoke has one of their great charts using data from the primary source on drilling activity, the Baker-Hughes weekly report.

052016-Baker-Hughes

 

Even if $50/barrel represents an intermediate high for oil prices there are important favorable consequences:

  1. The savings to the consumer, compared to recent years, remains large;
  2. The fears about failing companies and job losses, exaggerated and localized, will be less of a story.;
  3. The concern about banks failing due to oil company bankruptcies will be reduced.

Current oil prices may represent a sweet spot both for the energy sector and the overall stock market.

The Employment Report: Three Things You Should Know but Don’t

Reporting economic news is a major subject for the media. It starts with the facts, but after lingering briefly, attention turns to speculation about what this means for the boxed-in, painted-in, rock and hard place, corner-bound Fed. Take your pick of the metaphors, including plenty of mixed versions. You’ll hear them all. Probably tomorrow!

The financial world has plenty of self-proclaimed experts in “global macro.”  Many of these people never cracked an Econ textbook, and others did not even buy the Cliff notes! In an effort to improve investor understanding, I have added some of these topics to my “blog agenda.” (Suggestions for new topics are always welcome.

The employment report is universally regarded as the most important economic release. Employment is of clear importance to the Fed as a measure of economic strength. It is also a key issue in political discourse and public debate. If you consider this at all in your investing decisions, it is vital to have a good understanding of what can be learned from these data.

Here is a key starting point: The more complex the report, the more opportunity for spin.

If you want to be a good consumer of the commentary, here are three things that you need to know but probably don’t.

  1. Layoffs tell only half of the story.  Everyone watches weekly initial unemployment claims and stories about mass layoffs.  What about hiring?  We have no good reports about job creation.  Many sources have attacked the BLS Birth/Death adjustment.  It is so commonplace that it is routinely cited when it adds some jobs — used as a code phrase for fictitious jobs growth.

In fact, the long-term record of the birth death adjustment has been excellent.  Each quarter we get an update called the Business Dynamics report.  This never makes the news because it is eight months old.  That is unfortunate.  Unlike the monthly report, it is not an estimate based upon a survey sample, but a collection of data from local unemployment offices.  Companies have strong incentives not to overstate employment in these reports.

I use this report to gauge the accuracy of the various monthly estimates.  It separates job gains from new establishments from job losses from closing establishments.  The BLS monthly report begins with an assumption that “missing data” in the survey, when due to defunct companies, has been offset by new companies.  This assumption is far more important than the birth/death model, but the combination has been accurate.

In the latest period for which we have data, here are the gross and net job changes:

Table A.  Three-month private sector gross job gains and losses, 
seasonally adjusted 

Category                                 3 months ended

                                Sept.   Dec.    Mar.    June    Sept.
                                2014    2014    2015    2015    2015

                                      Levels (in thousands)
                                      
Gross job gains................ 7,235   7,658   6,947   7,554  7,292
 At expanding establishments... 5,905   6,279   5,666   6,220  5,958
 At opening establishments..... 1,330   1,379   1,281   1,334  1,334

Gross job losses............... 6,710   6,563   6,721   6,725  6,874
 At contracting establishments. 5,523   5,322   5,558   5,541  5,657
 At closing establishments..... 1,187   1,241   1,163   1,184  1,217

Net employment change(1).......   525   1,095     226     829    418

A little subtraction shows the net job gain from business births and deaths over the past year is 523K.  The b/d adjustment over the same period was 789K.  This discrepancy is minor on a monthly basis, or in comparison to the overall number of jobs.  I have tracked this for several years, and the differences are usually small and have no consistent bias.  Can we finally put this subject to rest?

2.  The BLS report is really just an estimate.  Many sources also estimate actual monthly net job growth with a variety of approaches.  Many of these (changes in state withholding, changes in private payroll reports, changes in national tax revenues) might well be better than that used by the BLS.  They basically estimate the size of an elephant each month via a survey. Then they subtract one month from the next.

The sampling error is over 120K, swiftly forgotten or completely ignored in the commentary. This error range is based on an accurate sample with 100% responses.  In fact, there are multiple revisions to the original estimate.  The margin of error applies to the final revised data, which we will not actually see for many months.

Despite the drawbacks in the BLS approach (and they are skilled statisticians doing a professional job).  It is viewed as “official”.  In my best post on this subject I explained that others doing estimates were not trying to measure “truth” but instead guess what the BLS would say!

3.  Evaluate the overall job changes, not the specific subsets.  Most commentators confuse job creation with net job growth.  They also give undue emphasis to sub-sector job changes.

Overall job creation is about 2.5 million per month!  Job destruction is only a bit lower.  Keeping this in mind helps to understand why so many feel the stress of unemployment.

The margin of error for specific subsets is much larger than people realize.  I explained this in 2010, but no one ever mentions these facts:

Sampling error means that the businesses or households chosen for the survey (even if all respond) may not accurately represent the actual population characteristic you are trying to measure.  If you learn this in a statistics class, you have a jar with a known percentage of black and white marbles from which you draw repeated samples.  As you do more samples, you come to realize that they reflect the underlying population on average, but often deviate.  There are statistical methods for estimating sampling error.  The BLS often cites a 90% confidence interval.

This is understood but usually overlooked in discussing the big headline numbers.  For the payroll report, for example, the 90% confidence interval is about 104,000 jobs.  Viewed in this way, we could infer that given our survey result actual job growth would be between -4000 and +204,000 about 90% of the time.

When the discussion turns to the various “internals” of these reports, the participants seem to forget that these are are also survey results.  Each item has its own 90% confidence interval.  Here are some selected examples:

Unemployment rate    +/- 0.16%

Size of labor force    +/- 490,000

Change in labor force MoM  +/- 400,000

Do you see why some of the glib commentary about the unemployment rate and the number dropping out of the labor force might be a bit overstated?  It is dangerous to infer too much from monthly changes, even when they seem like large numbers.  The errors are actually quite small in proportion to the entire size of the labor force.  Source:  http://www.bls.gov/opub/ee/empearn201005.pdf  (pp. 233-34).

Here are a few more examples:

Average weekly hours    +/- 1.65%

Average weekly earnings    +/-1.65%

Construction monthly change    +/- 24,000

The changes in weekly hours, viewed as such a negative this month, is well within the “noise” level.  Last month’s positive reading was only a bit outside the confidence interval.  People regularly comment on changes in various subgroup categories when the change is well within the confidence interval.  Here is the source for these and other results from the establishment survey.

Conclusion

The monthly employment report is a field day for pundits, but provides little solid information.  Understanding the economy requires a longer time period as well as alternative estimates.

  • Traders must guess the number (which they could not do even if they knew the “truth”) and also the market reaction.  Many think that a strong report will be negative because the Fed will be more likely to nudge rates higher.  Sheesh!
  • Investors once again have an advantage.  The volatility has little to do with the long-term prospects for your positions.  You may take what the market is giving you, whether trimming winners or acting on your shopping list.